Question

Ferguson Foundry Limited (FFL) manufactures two models of wood stoves, Basic and Deluxe. FFL’s president, Mark Ferguson, has just reviewed the financial statements of FFL for the fiscal year ended March 31. The results for the year were a shocking disappointment. Despite having sold more stoves than budgeted at higher prices, profits were less than expected in the budget.

In the fifth month of the year, the sales and marketing department realized that there was going to be much stronger demand than expected, due to announced increases in energy prices and a forecasted La Niña. Given that factory production is limited to a total of approximately 12,000 units, they decided to raise prices on both models. They decided on a price increase of around 30% for the Basic version and a price increase of around 2% for the Deluxe version. The purpose of this difference in percentage increases was to shift demand away from Basic to the more profitable Deluxe. In order to justify this increase in FFL’s new marketing materials, they authorized a change in the quality of materials used in producing the stoves. This resulted in an approximate 10% price increase for materials, but this seemed easily covered by the price increases, given that budgeted materials costs made up less than 33% of budgeted total costs.

Sales and Marketing seemed to make all the right moves, as they generated sales in units that were very close to capacity. They were all over in the sales office patting each other on the back and high-fiving one another’s “genius.” Every once in a while, one of the sales staff would yell out, “Who did it?” and everyone in the office would scream in unison, “We did it!” One particularly brash sales person even threatened to leave the company if Mark didn’t “properly” recognize his department for “all the money we put in the pockets of Mark’s family.”

However, things were much more somber in the manufacturing plant. They were reeling from the flurry of activity over the past seven months. It had been difficult to handle the increase in production. A major reason was that it was impossible to hire more skilled labor. The production manager had to choose between paying skilled labor overtime or shifting work to the unskilled labor. Since skilled labor received $24.75 for an overtime hour, the equivalent to almost two hours of unskilled labor, he decided to reduce the hours that skilled labor spent on Basic and hire more unskilled labor to get the work done. However, even that had been a difficult order for human resources to fill, and he ended up having to pay unskilled labor overtime to generate enough hours to get the work done. On top of that, the unskilled workers lack of experience resulted in a significant amount of wasted time and materials in making the Basic product. Exasperated, he had told Mark, “And to top it all off, our variable overhead number for Basic is higher than budgeted! How can that be the case when our volume is down? That can’t be my fault! Those accountants are always sticking me with some costs that I don’t understand.”

The following information is available: a statement of standards prepared as part of the budget process (Exhibit A), some actual market and job-cost data (Exhibit B), and a statement of budgeted and actual results (Exhibit C).

Exhibit A

Unit Cost Standards

Cost Standards:

	Basic	Deluxe
Materials per Unit	70 kilograms	190 kilograms
Labour per Unit (unskilled = 37.5%, skilled = 62.5%)	6 hours	16 hours
Variable Overhead is based on Labour Hours
Variable Selling and Administration is based on Sales Volume

Exhibit B

Actual Cost Data

	Basic	Deluxe
Materials Used (kilograms)	603,000	997,500
Actual Hours – unskilled	31,825.0	31,500.0
– skilled	20,100.0	52,500.0

Exhibit C

Static Budget and Actual Results

For the Year Ended May 31

	Static Budget
	Basic	Deluxe	TOTAL
Sales volume (in units) (10% of total market share)	7,200	4,500	11,700
Sales revenue	$ 2,160,000	$ 3,600,000	$ 5,760,000
Variable costs:
Direct materials	504,000	855,000	1,359,000
Direct labour – unskilled	202,500	337,500	540,000
– skilled	445,500	742,500	1,188,000
Overhead	324,000	540,000	864,000
Selling and administration	108,000	180,000	288,000
Total variable costs	1,584,000	2,655,000	4,239,000
Contribution margin	$    576,000	$    945,000	$ 1,521,000
Fixed costs:
Manufacturing			750,000
Selling and administration			132,500
Total fixed costs			882,500
Operating income			$   638,500
	Actual Results
	Basic	Deluxe	TOTAL
Sales volume (in units)	6,700	5,250	11,950
Sales revenue	$ 2,345,000	$ 4,252,500	$ 6,597,500
Variable costs:
Direct materials	633,150	1,047,375	1,680,525
Direct labour – unskilled	460,325	393,750	854,075
– skilled	336,600	866,250	1,202,850
Overhead	394,630	638,400	1,033,030
Selling and administration	100,500	210,000	310,500
Total variable costs	1,925,205	3,155,775	5,080,980
Contribution margin	$    419,795	$    1,096,725	$1,516,520
Fixed costs:
Manufacturing			780,000
Selling and administration			139,500
Total fixed costs			919,500
Operating income			$   597,020

Given the expected 5,628-hour increase in the flexible budget for unskilled labor, how much did inefficiencies of unskilled labor cost FFL in compensating skilled labor?

Given the expected 5,628-hour increase in the flexible budget for unskilled labor, how many additional hours did unskilled labor work?

How much did wasted materials cost FFL?

How many kilograms of materials were wasted in the production of Basic?

Answer 1

Actual sales data of

Basic Units- 6700 units

Material per unit = 70 kg

Total direct material used should be = 70* 6700 = 469000 kgs

Actual Direct material used = 633150

Total material wasted = 633150-469000 = 164150 kgs

For Deluxe Unit

Material required per kg = 190

Total units made/sold = 5250

Total direct material required = 5250*190 = 997500

Total direct material used = 1680525

Total wasted material = 1680525-997500 = 683025 kgs

Total wasted material cost = 683025+164150 = 847175 kgs

Total material wasted in Basic Unit Production = 164150 kgs

Labour per unit required for 1 unit of Basic = 6 hours

Total units sold = 6700

Therefore, total production time required should have been = 6*6700 = 40200 hours

Skilled labour uses 62.5 % of time, therefore time for skilled labour = 25125

Uskilled labour uses 37.5% of time, therefore time for unskilled labour = 15075

Total production time it took was = 31825 (unskilled) + 20,100 (skilled) = 51925

For Deluxe units

Time per unit = 16 hours

Total units produced = 5250

Total production time should have been = 5250*16 = 84000

Time for skilled ( 62.5%) = .625*84000 = 52500

Time for unskilled (37.5%) = .375*84000 = 31500

Total Time used = 31500 unskilled + 52500 skilled = 84000

Hence time was not lost here

How much did inefficiencies of unskilled labour cost

We see, that for Basic unit, total production time required was 40200 hours

Total time that was used was = 51925 hours

Hence total loss was of extra = 51925-40200= 11725 hours

How much additional hours did unskilled labour work =

Unskilled labour worked for 31825-15075 = 16750 hours

As the actual cost that labour took for overtime and normal time for skilled and unskilled workforce is not given, we cannot calculate the actual lost hours in terms of money that it costed to FFL